If you missed my previous post on the performance of our Harmoney account, you can check it out here.
Analysis of Harmoney performance has alerted me to the recently introduced practice of loan re-writes.
The below is Harmoney’s explanation of their re-write process. This information is quoted directly from Harmoney’s response to an email that I sent them.
What is a loan rewrite?
In short, it means that the borrower has requested to increase the amount they have borrowed.
Harmoney offers this option to creditworthy borrowers who have demonstrated a reliable repayment record for a minimum of three months, allowing borrowers to extend their loan amount up to their maximum approved limit.
How does a rewrite work?
When borrowers apply to top up their loans, the loan contract terms must be changed, therefore the original contract becomes void. For this reason, borrowers must have the new loan total (original loan outstanding amount + top up amount + platform fee) fully funded by investors.
Once the new loan total is funded, the outstanding balance of the original loan is paid back to investors, and the borrower receives the top up amount. The original loan is then considered repaid and closed.
In the event that a rewrite does not reach full funding on the marketplace, the borrower’s original loan continues without change.
What happens when a loan I have invested in is rewritten?
You will be repaid the outstanding principle and interest, less the service fee. The repaid funds will be available in your account for withdrawal or reinvestment.
An investors interest income will always exceed the amount of service fees incurred because a rewrite can only occur after 3-months of consecutive payments that are on-time and in full.
So what are the advantages and disadvantages of re-writes?
From the Borrower’s Perspective..
How is eligibility for top-up assessed?
Isn’t the borrower already offered the maximum limit at the time the original loan is set up?
Will the re-written loan be at a higher grade and interest rate due to the same income, but higher debt level?
Isn’t it then cheaper for the borrower to keep the original loan and get a second small loan somewhere else for the extra?
From the Investor’s Perspective..
Investing has become far less passive. The investor now has to check every couple of days for paid off notes that need to be reinvested, otherwise unplaced notes are not earning any interest.
Re-writes have an adverse effect on interest rates as every paid off loan incurs a service fee on principal as well as the interest received. The service fee on every paid off note is a minimum of 31 cents (1.25% of $25) regardless of how much interest has been received.
An investor also needs to take into account the downtime of funds whilst they are waiting for a loan to fund (not earning interest) and then there is the first month of the loan before any interest is received. Re-writes will mean a lot more downtime for investors before seeing any actual return on their money.
From Harmoney’s perspective:
Harmoney are charging the borrower a fee for the original loan and then another fee for the top-up.
Harmoney are also charging the investor the service fee on the original loan and then charging the new investors the same service fee on the re-written loan.
The way I see it, the only winner is Harmoney!
What can be done about this?
If you are a borrower, be sure to shop around if you need a loan top-up. Having all your debt in one place might be convenient, but if it is all at a higher interest rate simply for convenience, it is not worth it! If the extra amount you need can be satisfied by a credit card then you might want to consider setting yourself up to take advantage of the banks’ competitive balance transfer offers.
If you are already in need of extra funds, paying another loan set-up fee is not going to help your situation. A credit card is also likely to be cheaper in this regard too.
You do need to be disciplined though to pay the card off!
If you are an investor, choose the highest risk loans. This is to minimise your exposure to re-writes as you would assume that those already in the highest risk bracket must be borrowing the maximum they can afford based on their incomes. These higher risk loans also offer the highest interest rates so that you stand a better chance of getting a decent return even if the loan is paid off early.
If you take the lowest risk loan, an A1 grade paying 9.99%, a rough calculation would show that you would get around 62 cents in interest after 3 months. If this loan were to be re-written at the 3 month mark then Harmoney would take a service fee of 32 cents, so you only gain 30 cents before tax. Although, tax will be calculated based on the 62 cents that you have earnt (with no regard to Harmoney’s service fee), so you’re being ripped off in this respect too! At a return of 4.87% before tax it is still better than the bank, but probably not worth the hassle of constantly checking your account and placing notes?
The spreadsheet below shows the effect of a 3 month re-write on the investor’s interest rate.
A graph of the data shows that for an annual 20% return, allowing for re-write possibility, you’d want to choose an E2 or riskier investment. Be aware that this doesn’t factor in anything for default risk, so you’d be looking well into the F grades to cover default risk as well as early repayment/re-write risk.
What can Harmoney do to reduce the impact of re-writes on investors?
Whilst I acknowledge that Harmoney needs to make money to stay in business, they also need to consider both their borrowers and investors and see if there is a way to make re-writes more attractive to both sides.
For a start, I believe that service fees for loans that have been paid off as re-writes should be nil. The reason I say this is because Harmoney are double-dipping with these fees as the new loan is for more than the old loan, so they will get their fees when the new re-written loan is paid off. If Harmoney want to rewrite loans so that they start again for 36 or 60 months, then Harmoney will have to wait longer to get their service fees. The simple fact is that the original investor is not getting the service that they are paying the fee for. The original investor took a contract in a note for 36 or 60 months, with the risk that the borrower could pay it off at any time without penalty. The problem is that the borrower is not paying the loan off, Harmoney is.
Although the service fee is small, it is the principle that gets my hackles up a bit.
Re-writes are creating a more active investment for investors who like to choose their own loans to invest in. We have stopped putting money into Harmoney for the moment to see what, if anything, changes with the re-write system.
It would be very helpful for investors if the original loan ID had a link to the re-written loan so that we can see how much extra the borrower has accepted, and at what grade/interest rate. Vice versa for the re-written loan. The new investor should be able to see the details of the original loan so that there is full transparency.
I’d like an alert on re-written loans advertised for funding if they are at the maximum top-up limit. This would give the investor confidence to invest in that loan without the risk of a further re-write.
I’d also like Harmoney to consider why they have chosen 3 months as the time period before offering a top-up. Three payments hardly constitutes a good track record. Perhaps a year would be more palatable to investors?
I don’t mean this post to slam Harmoney, but these are genuine concerns that I have as an investor, and I believe it useful for others to also be aware of the re-write situation.
As an investor, your Harmoney investment is still likely to have a better return than having a term deposit with a bank, it’s just not quite as good as Harmoney would have you believe.
You need to be aware that Harmoney loans are no longer passive investments. I believed that we were locking our funds up for 36 or 60 months and only expecting a small portion back each month in repayments and interest. Due to re-writes, you would be unwise to leave your account unchecked for long periods of time.
Please add your comments below if you have questions, or solutions, for Harmoney on the issue of re-writes.